Pandemic exposes ‘severe stress’ in commercial property financing 

Mortgage-backed securities fill a funding gap but as delinquencies rise investors are bracing for losses

Joe Rennison in London


© FT montage; Dreamstime



Over the course of 150 years, America’s oldest continuously running hotel has never been closed for this long.

Yet, as stay-at-home orders took hold in March, all but one of the 1,641 rooms at the Palmer House Hilton in the centre of Chicago began to empty out, with the hotel eventually suspending operations on April 28 for all except a single long-term resident. 

Its wide marble staircase now leads down to a near silent lobby after Hilton, which manages the property on behalf of the real estate investment firm Thor Equities, furloughed more than 90 per cent of the hotel’s 900 staff. 

The fate of the property is not only emblematic of the severity of the crisis emerging for the hotel industry but also of the pressure building across the commercial real estate sector — from small-town malls to sky-high office blocks — hitting one of its primary sources of financing; the $1.4tn market for commercial mortgage-backed securities.

“I don’t think anyone foresaw the devastation that Covid would wreak on commercial real estate and the CMBS market,” says Lea Overby, an analyst at Wells Fargo who has covered the sector for almost two decades.


The pressures on America’s malls, such as the Destiny in Syracuse, New York . .. © Alamy


. . . have been accelerated by the pandemic as properties empty and shoppers move online © Alamy



CMBS take either one, very large commercial mortgage — as is the case with the Palmer House deal — or bundle up a group of smaller property loans in what is known as a “conduit” deal. 

The mortgages are then used to underpin the sale of layers of fresh debt, with cascading exposure to the default of the underlying mortgages. The mortgage payments on the property, or properties, are then used to repay investors, such as fund managers and insurers. 

Those investors are now bracing for losses, sitting at one end of a chain of turmoil that links millions of workers suddenly without jobs or furloughed after hotels, shops and offices closed their doors, to building owners in the middle, facing the prospect of handing the keys over to their lenders. 

“This is severe economic stress,” says Ms Overby.

‘Zero to 60 in two seconds’

When Potter Palmer first built Palmer House in 1871, the hotel lasted just two weeks before it burnt to the ground in the great Chicago fire. Palmer, a local businessman, immediately began work rebuilding the property, financing it with $1.7m in unsecured debt — believed to be the largest ever individual loan at the time.

A century and a half later, the financing for the property has evolved. Thor Equities bought the property from Conrad Hilton in 2005 for $230m. Following a $170m renovation, Thor negotiated a new $330m mortgage on the property with JPMorgan, which was subsequently sliced up and used by the bank to underpin a CMBS deal sold to investors in 2018. 


The Palmer House Hilton in Chicago, one of America’s longest running hotels, suspended operations on April 28 . . .  © Alamy


. . . its fate is emblematic of the severity of the crisis emerging for the hospitality industry © Alamy


As coronavirus spread in the US, revenues at the Palmer House fell. Thor has not made its monthly mortgage payment since April. Instead, it requested a six-month forbearance on its loan due to “Covid-19 concerns”, according to servicing notes in a document from Wells Fargo, the deals’ trustee. The Wells Fargo document dated August 17 lists the property as being in foreclosure. “Default notices were sent to the borrower,” it notes.

“The entire hospitality industry has been devastated by the pandemic,” said Thor Equities, in a statement to the Financial Times.

The impact of the pandemic is being felt across other property types too. Malls remain empty as shoppers’ shift online. Office blocks face an uncertain future as the effects of working from home begin to alter companies’ requirements for desk space. Renters in apartment blocks face challenges as government programmes to support consumers dwindle. 

Approaching the end of August, almost a quarter of all hotel loans bundled into CMBS had failed to pay their mortgage for at least 30 days — classified as delinquent — followed by 15 per cent of retail loans, according to data from Trepp. 

Bond investors have responded accordingly. In the CMBS deal backed by the Palmer House Hilton, the original triple-B-rated tranche — a rating that signalled it was a reasonably safe “investment-grade” asset — has slumped to below 80 cents on the dollar. Moody’s has cut the debt to a junk rating.

Chart showing rise of ommercial mortgage-backed securities delinquencies


“In 2009 it took some time before we saw significant commercial real estate delinquencies,” says Alan Kronovet, head of commercial mortgage servicing at Wells Fargo, declining to comment on the Palmer House loan specifically. “In this pandemic we went from zero to 60 in two seconds.”

Filling a funding vacuum

In February 1994, shortly after he had struck one of the first CMBS deals, Ethan Penner threw a weekend event for the emerging industry at the Boca Raton Resort & Club in Florida.

For the previous three years he had worked to bring together commercial real estate owners and bond investors that up until then had no cause to have any dealings with one another. That night, Elton John played for two and half hours to 500 guests, says Mr Penner, who is widely credited as the architect of the CMBS industry. “Grown men were crying,” he adds.


The once bustling buildings around the Westin Bonaventure Hotel and Suites, Los Angeles, now stand empty © David McNew/Getty


The CMBS market grew out of the decade-long savings and loans crisis that began in the mid-1980s, and which saw the demise of over 1,000 savings and loans institutions crucial to financing commercial real estate. It left a vacuum in funding for the industry. “All the capital providers abandoned the business at the same time,” says Mr Penner. “The real estate industry found itself without a lender.”

While leading real estate figures like Sam Zell turned to public equity markets, Mr Penner thought CMBS could provide a solution. He joined Nomura in 1993 with the intention of developing the market.

The basic mechanics of CMBS remain much the same as they were in those early deals. Lenders — often banks — originate loans that are then sold to a trust. The trustee effectively acts on behalf of investors that buy bonds backed by the payments on the loans. A master servicer is appointed to collect the payments and deliver them to the trust.


The empty lobby at International Place in Boston’s financial district is a sight echoed across the country © David L Ryan/Boston Globe/Getty


There are three main master servicers in the US — Wells Fargo, KeyBank and Midland Loan Services. If borrowers fail to pay, the servicer will advance the funds up to the value of the property collateralising the loan.

Most of the debt is rated triple-A, with agencies comfortable giving such high-quality ratings to those tranches because of the protection provided by the lower-rated tranches, which absorb losses first.

The market grew rapidly into a $900bn industry — responsible for over 50 per cent of commercial real estate funding before the 2008 financial crisis — according to data from Bank of America and the Commercial Real Estate Finance Council. Much as it was for residential mortgage bonds that fuelled the economic downturn, the next few years proved a reckoning for the loose underwriting and weak protections that had taken hold in the boom years. 

“Over time the standards in the market reduced and reduced,” says Joel Ross, a veteran of the hotel CMBS industry. “By 2006 the standards were almost non-existent. By 2007 if you were breathing you could get a loan.”

In the decade since, analysts say underwriting in the industry has improved and rating agencies have begun requiring more protection for investors in the highest rated tranches. What's more, the dominoes of derivatives and financial alchemy that toppled the housing market in 2008 and knocked through the broader economy are less pronounced for commercial mortgages. 

But vulnerabilities remain.

Line chart of Basis points, by rating showing The changing spreads for CMBS tranches


Need for greater protection

Moody's warned last year that the protection from defaults for higher-rated tranches of conduit CMBS deals was too low, saying the market had stopped soliciting their ratings as they became more stringent.

Ahead of the last downturn, this default protection for the average triple B-rated bond sat at just above 3 per cent of the loan balance. That means that 3 per cent of the total owed by borrowers underpinning a CMBS deal could remain unpaid and triple-B tranche investors would still get their money back

Analysts and investors say that has now risen to around 7 per cent. Wells Fargo analysts anticipate overall losses rising to between 6.5 per cent and 8.7 per cent over the lifetime of a typical CMBS deal. “When we are talking to investors we are very upfront that a lot of triple Bs will take a loss,” says Ms Overby, “and some will take a big loss”.

Kevin Fagan, a senior credit officer at Moodys, says that such widespread losses is exactly what the rating agency had tried to warn against. “We did not think the enhancement going into this crisis, for years before, had been sufficient.”


The crisis has hit one of the primary sources of real estate financing; the $1.4tn market for commercial mortgage-backed securities © Alexi Rosenfeld/Getty


For bonds backed by a single, large mortgage, the story is a little different. Credit enhancement is more varied, depending on the specifics of the deal, but it is normally much higher due to the greater risk of being dependent on the performance of just one property. In the case of the Palmer House Hilton, investors in the triple-B-rated bond are protected from almost 33 per cent of losses, according to the trustee report. 

Edward Shugrue, who runs a $300m CMBS fund at RiverPark, the Kansas City-based fund manager, is “exceedingly comfortable” holding the Palmer House backed debt. He does not expect Thor to recover and repay the mortgage. Instead he anticipates the storied property will be sold and that he will get his money back. 

“This hotel has lived through the Spanish flu and guess what, it is still standing,” says Mr Shugrue. “Palmer House is always going to exist.”

Investors in other properties are more sceptical. The Destiny Mall in Syracuse, New York, is one of the largest regional shopping centres in America. The triple-B-rated tranche of the CMBS backed by the property has been downgraded by Kroll to triple C, implying a high likelihood that it will default. 

Even the double-A-rated tranche — awarded the stellar rating by both Kroll and S&P — has slipped to a junk rating of double B. Investors say they have seen the tranche traded in the market for as little as 50 cents on the dollar. 

The pressure on America’s malls has been accelerated by Covid-19 as more shoppers move online. The properties are also harder to repurpose, say analysts, impinging on the possible recovery value to investors in the bonds if the malls are sold. It’s a similar story for some hotels. 

The trustee documents note that Palmer House has had an appraisal of its value that came in at almost $30m less than the value of the mortgage.

“Why would you want to own these properties?” asks Mr Ross, the industry veteran, “what are you going to do with them?”

Column chart of $tn showing Outstanding US commercial mortgage-backed securities

Call for more protection

The pain in the market has led to calls for assistance from Washington. Other industries have received help, so too should commercial real estate, argue industry groups.

Thor Equities said that Palmer House had so far been ineligible for government support, like many other properties. “We are hopeful the government stimulus plan will help these places of employment for so many individuals and numerous adversely affected communities,” the company added.

The Federal Reserve has stepped in to purchase some of the senior most, triple A rated securities of deals but proposals for a more substantial intervention pose problems. 

Critics, both inside and outside the CMBS industry argue that a bailout would simply protect institutional property owners — like private equity firms and real estate companies — from losses, while putting taxpayer money at risk and leaving those laid off as businesses have closed their doors still unemployed. 

“The real estate industry wants to bail out borrowers who knew exactly what they were getting into with these loans,” says Marty Leary, research director at Unite Here, a union for hospitality workers. “Don’t say this is about employment. This [support for CMBS] will not bring back a single job.”

There are more structural issues as well. CMBS tend to prohibit mortgage borrowers taking on more debt, which has been the government’s proposed solution in other areas of the economy. 

Instead, lobbyists are pursuing a riskier alternative, calling on the government to lend money at a fixed interest rate through what is known as preferred equity. The Helping Open Properties Endeavor bill has been introduced in the House of Representatives but has yet to be enacted. Essentially, it is asking the US government to lend money to ailing properties and then to take losses ahead of bondholders should things turn sour. 

“The question is whether this is a bridge or a crutch,” says Lisa Pendergast at the Commercial Real Estate Finance Council. “We see it as a bridge to Covid’s end.”


Even in the best-case scenario the US commercial real estate sector may have fundamentally changed, leaving CMBS bondholders carrying the bag © David McNew/Getty


Even without additional government aid, there are glimmers of hope. The price of debt in the CMBS markets has rebounded from its nadir in March, with the recovery most pronounced in the higher-rated tranches. New deals — mostly avoiding sectors worst hit by coronavirus — have also managed to be sold, breathing new life into the CMBS market. 

The industry is far from being on a firm footing, however. Even in the best-case scenario, with a broad economic recovery in the US, office properties will struggle to repay rent if businesses scale back on floor space. Hotels catering to conferences will struggle if companies stop spending money on business trips. That means bondholders in CMBS may still be left holding the bag. 

“We could simply have less demand for commercial real estate,” says Ms Overby. “My biggest fear is that the sharp rebound we are hoping for doesn’t materialise. If it doesn’t come there will certainly be another leg down within commercial real estate.”

Big fish

In twenty years, exchanges have gone from clubby firms to huge conglomerates

They control everything from the software powering back offices to the data pored over by investors




The hong kong Stock Exchange (HKEX) resembles a financial estuary, says Charles Li, its boss.

China’s capital flows mix with the open seas of global markets. In 2014 HKEX sought to ride the waves by launching Stock Connect, a conduit allowing offshore and mainland punters to invest in each other’s markets.

Later it eased its listing rules for firms with dual share classes. All that has helped make HKEX more hospitable to the tech firms that exchanges covet. It has just landed another big catch.

On August 25th Ant Group, the fintech affiliate of Alibaba, a Chinese e-commerce giant, filed for a listing that may raise $30bn in Hong Kong and Shanghái. That would make it the largest initial public offering ever.

The news made a splash. But it is easy to forget that, in the two decades or so since they themselves listed, HKEX and other exchanges have become big fish too, by exploiting the benefits of network effects, data and scale that Big Tech is best known for. 

The London Stock Exchange, which was worth less than $2bn when it went public in 2001, now has a market capitalisation of $41bn. The New York Stock Exchange (NYSE) is now part of Intercontinental Exchange (ICE) which is worth $57bn (see chart 1). HKEX’s market capitalisation has grown nearly sixty-fold, to $61bn. Their revenues similarly boomed.

Once crusty monopolies, exchanges have continually stretched their business models. They still run the match-making infrastructure that allows billions of shares and trillions of dollars to change hands daily. Stacey Cunningham, who helms NYSE, says it received over 300bn messages across its systems on peak days this spring; that is more than 50 times the number of daily Google searches.

But after two decades of epic bidding wars and political drama, exchanges are also remarkably powerful financial conglomerates, controlling everything from the software powering banks’ back offices to the data pored over by investors. The race for dominance means that, today, a small group of elite exchanges are far ahead of the rest.




Stock exchanges used to be owned by their members, which were mostly banks and brokers.

When the biggest went public in the 2000s, they earned their crust by charging fees on equity issuance and transactions. 

The exchanges sought to diversify by expanding abroad and becoming trading venues for other assets, like derivatives and currencies. Most moved into clearing and settlement facilities, too.

For much of that period, “eat or be eaten” was the industry’s motto. In 2007 NYSE bought Euronext, a group that included the Amsterdam and Paris exchanges. ICE bought nyse in 2013 (and spun out Euronext). Yet the strategy soon came up against antitrust and political vetoes.

Attempts to marry Toronto’s stock exchange with LSE, LSE with Deutsche Börse, Deutsche Börse with NYSE, have all collapsed. Most recently, in 2019, an opportunistic bid by HKEX for the LSE fell through.

With deals proving tricky the firms have found crafty ways to expand. As passive funds came to prominence, trading venues set their sights on benchmarks tracked by these funds. 

In 2010 Chicago Mercantile Exchange (CME), a big derivatives market, acquired Dow Jones, which assembles many of America’s most widely followed indices. LSE has a number of benchmarks that cover both sides of the Atlantic. (Updates to such indices—like the ejection of ExxonMobil, an oil firm, from Dow’s flagship index on August 25th—can cause mountains of money to shift).

Now the elite exchanges have turned their attention to data. On August 6th ICE said it had agreed to pay $11bn for Ellie Mae, which tracks the mortgage industry. LSE is awaiting approval of its $27bn bid for Refinitiv, a market-data firm. 

The hunt, says David Schwimmer, LSE’s boss, is only beginning. Whereas trading volumes are cyclical, indices and data are typically sold via more stable subscriptions. Oliver Wyman, a consultancy, expects trading revenues to stagnate or even decline, but those from crunching data to grow by over 5% annually in coming years.

Twenty years ago the fear was that new entrants would eventually topple the exchanges’ de facto monopolies. But the incumbents have kept the challengers at bay. Customer complaints about their fat fees once enticed startups, such as iex, an exchange that pledges fairer pricing.

The rise of “dark pools”—venues that match buyers and sellers anonymously—also posed a threat. But seven years since it was founded, iex’s market share is stuck at 1.8%. The share of trading volume accounted for by dark pools in America has stabilised at 12%.

The result is a pyramidal hierarchy, a good gauge of which is an exchange’s revenues. At the base are the minnows, in poor countries or small developed ones, which lack liquidity or scale and are struggling to diversify. 

Some should merge or close, but governments will keep them alive. “Every nation wants to have a strong airline, a good beer and a stock exchange,” says Nick O’Donnell of Baker McKenzie, a law firm.

The next tier consists of exchanges with regional heft, and revenues exceeding $500m. Their reliance on trading in an era of tensions between America and China means they must team up or play to their strengths as neutral turf in order to thrive. 

On August 20th Singapore Exchange said it would work with lse’s benchmark business to develop index derivatives focused on Asian and emerging markets. Euronext has acquired Nord Pool, a power market.



At the top of the food chain, with revenues at or exceeding $3bn, sit the giants: CME, Deutsche Börse, ICE and LSE. These have assured demand for big volumes, and will continue to reap the rewards of diversification.

Two candidates are on the verge of promotion into the top league. Nasdaq, once famous only for its tech listings, now makes software that powers more than 130 other exchanges. HKEX enjoys the strongest tailwinds. It stands to win from China’s capital-market liberalisation, its growing tech nous and mainland firms’ desire to be closer to their home market.

Geopolitics could also help, as Ant’s decision not to list in America may already show.

In time, Mr Li reckons, “almost all” Chinese companies listed in America will come back to Asia. Stock Connect, which makes up 7-8% of daily trading on HKEX, could end up accounting for a quarter of it. 

Being at the confluence of China’s rivers of capital and the sea of global funds should be a lucrative business.

In Russia, Mercenaries Are a Strategic Tool

Companies like the Wagner Group fill in certain security blanks

By: Ridvan Bari Urcosta



Belarusian intelligence has accused Russia of sending private citizens to interfere in the country’s affairs and generally engage in acts of provocation. These same citizens participated in the annexation of Crimea a few years ago and fought on Russia’s behalf in the breakaway region of Donbass, according to officials in Ukraine, who demanded their immediate extradition to Kyiv. Instead, the Belarusian government sent them back to Russia.

To no one’s surprise, the citizens were members of the infamous private military company known as the Wagner Group, which over the past few years has been involved in every international conflict strategically important to Russian interests. The case of Belarus and Ukraine – the first instance on record of Wagner operating so close to NATO’s eastern flank – underscores just how useful a political tool Wagner has become for the Kremlin.

Organization and Formalization

Private military companies are by no means unique to Russia, but Wagner has a unique Russian flavor. The collapse of the Soviet Union and the concomitant depression left thousands of Russian soldiers rudderless.

They were unemployed but well trained and ready to fight, so they informally banned together in the 1990s to sell their services throughout Eurasia. By 2008, there were no fewer than a dozen private military companies in Russia. The most famous of them, the one that would serve as the blueprint for Wagner, was officially created in 2013 in response to the Syrian civil war.

Known as the Slavonic Corps, the group comprised former Russian special forces whose primary task was to protect the oil fields near Deir el-Zour. This naturally led to clashes with the Islamic State.

Among the members of the Slavonic Corps was Dmitry Utkin, a former special forces commander in the GRU, Russia's military intelligence unit, more commonly referred to by his call sign, “Wagner.”

Most would be arrested for mercenary activities when they came back to Russia. (The legal status of private military companies is murky. Officially they are illegal, but they are “coincidentally” deployed to areas vital to Russian interests. One of the Wagner Group’s biggest benefactors, a billionaire named Yevgeny Prigozhin with oil and mining operations in Africa and the Middle East, is tight with Russian President Vladimir Putin.)

Either way, the Wagner Group returned to Syria in 2016 and cooperated closer with Russian regular forces. They are believed to have participated in the assaults on Palmyra in 2016 and 2017, and they are rumored to have fought with Syrian forces, and thus against U.S. forces, in the battle of Khasham in 2018.

The group has since expanded its reach considerably, particularly in Africa. It trains the military in Sudan, which reportedly granted mining concession agreements to a company tied to Prigozhin. It has participated in military parades in the Central African Republic, and is thought to be in Burundi as well. Its most high-profile client, of course, is Libya.

The United Nations estimates that more than 1,000 Wagner members are fighting alongside the Libyan National Army, led by Field Marshal Khalifa Haftar. The document says that mercenaries help to repair military equipment and also perform the functions of gunners, sappers and specialists in electronic warfare.

Putin denies funding or supporting them; in fact, he has said explicitly that they do not represent the Russian government in any way. But curiously, Haftar met directly with Putin and Prigozhin back in 2018, and by 2019, the group was reportedly assisting in Haftar’s attempt to retake Trípoli.




Leverage and Maneuverability

This partly illustrates the allure of Russia’s private military companies: plausible deniability. They simply don’t have the political baggage of total state affiliation, which gives Moscow political leverage and maneuverability.

They are well trained, they have their own equipment and training facilities – the primary one located in Molkino in Krasnodar Krai near the Black Sea – and even have their own airfield. Yet, they are also relatively cheap on the global market. Salaries for the average soldier start at $2,000 per month but can go as high as $20,000 per month.

The low end of that spectrum may seem low, but it’s higher than enlisted pay in the Russian armed services. (It should be noted that reports from 2017 suggested salaries had dropped.) Money comes from private sources, local governments that want to use their services and, allegedly, classified disbursements from the Ministry of Defense.




So even though Moscow can claim not to use private military companies, it makes sense that it would. Groups like Wagner can secure facilities conventional militaries can’t or won’t for political purposes, and thus they are perfect for non-linear and limited-scale conflicts. (They tend to fare worse against conventional militaries.)

They usually work more closely with local security forces and help to organize those forces.

Moreover, military campaigns conducted between states can be complicated and logistically complex. Private companies can simplify this process. And ultimately they give Russia another contingent of forces to work with. When Putin announced plans to partially withdraw from Syria, Moscow thought it could offset the losses with private military companies.

Notably, Russia’s preference for private military companies is a relatively recent development, one ushered in by the conflicts in Syria and Ukraine, which made it clear to Moscow that the Wagner Group is an effective supplementary global tool. Maintaining semi-official groups enables the Kremlin to send them into dangerous places to secure Russian companies’ interests without officially claiming responsibility.

They fill out the strategic blanks, forming a sort of symbiosis between the state and the private groups whereby the state allows soldiers of fortune to earn money. In return, the state gets subordination and partial cover-up.

It’s a small but important part of the Russian grand strategy. Russia will continue to use the private military companies as an instrument of its global strategy in the near future especially under Putin’s rule.

The Dark Heart of Gold

The US Federal Reserve has rightly eased monetary policy aggressively since the onset of the coronavirus recession in March. But gold bugs would take the recent record-high price for the metal as a sign that the Fed should tighten monetary conditions sharply.

Jeffrey Frankel

frankel114_aydinmutluGetty Images_dollargold


CAMBRIDGE – The price of gold reached an all-time high of $2,000 per ounce in early August.

And while mainstream economists have treated gold as a sideshow since the world abandoned the gold standard in 1971, this recent price spike is a significant signal.

Three explanations for the elevated gold price – related to US monetary policy, risk, and investors’ growing desire for a safe-haven alternative to the dollar – have been offered. Each contains some truth.

The US Federal Reserve has eased monetary policy aggressively since the onset of the coronavirus recession in March. True, there currently is little sign of inflation – for centuries a major motive for holding gold.

But rising goods prices are not the only sign of easy money. Today’s low real interest rates, depreciated dollar, and high stock prices – not to mention the size of the Fed’s balance sheet – all reflect the Fed’s accommodative monetary-policy stance.

A low real interest rate is often associated with a high real price of gold, both in theory and empirically. After all, the long-time argument that gold doesn’t pay interest is less persuasive when other assets are also yielding scant returns.

The last decade confirms the correlation. The gold price was almost as high as it is now in 2011-12, during the Fed’s second and third rounds of quantitative easing (QE).

It then fell to $1,200 per ounce during the “taper tantrum” that followed then-Fed Chair Ben Bernanke’s May 2013 announcement of plans to end QE.

Another age-old reason to invest in gold is to hedge against risk, because the gold price, although highly variable, tends to correlate relatively weakly with prices of other securities. For obvious reasons, risk perceptions have been elevated since February, as reflected in policy uncertainty indices and the VIX (the so-called fear index).

Gold is typically one of several safe-haven assets to which risk-averse investors flee.

Although the dollar has long been the world’s leading safe-haven currency, the increasing eagerness of many investors’ to diversify their holdings partly reflects US President Donald Trump’s weaponization of the greenback, using – or abusing – its status as the leading international reserve currency to enforce unilateral US sanctions extraterritorially.

Another likely factor is widespread loss of confidence in the competence of US governance, with the most egregious example being Trump’s mismanagement of the COVID-19 pandemic.

The end of the dollar’s preeminence has been prematurely declared many times, and no obvious challenger has yet emerged. The world’s second most important currency, the euro, lags far behind the dollar in measures of international use. Meanwhile, the Chinese renminbi, heralded as a potential challenger not long ago, is only fifth, seventh, or eighth in the rankings, depending on the criterion used.

Gold is not a currency, but it rivals the dollar as an international reserve asset and has thus benefited from the desire for diversification. Moreover, the dollar’s depreciation since April against the euro and most other major currencies itself partly explains the increase in the dollar price of gold.

The heyday of the international gold standard (under which most leading currencies were convertible into gold) ended in 1914, with the advent of World War I. But the arrangement continued to play an important role until August 1971, when US President Richard Nixon surprised the world by abruptly ending the dollar’s convertibility into gold.

Today, however, the gold standard is of more than antiquarian interest. In January, Trump nominated Judy Shelton – who made her reputation as a dyed-in-the-wool proponent of the gold standard – to be one of the seven governors on the Federal Reserve Board. The Senate Banking Committee voted to approve her, along party lines, on July 21, and her appointment could come up for a final vote as early as September.

Shelton’s views go beyond nostalgia. “Let’s go back to the gold standard,” she wrote in February 2009. She favors abolishing the fiat dollar as legal tender.

But returning to a gold-based monetary system is a terrible idea. Even if low and stable inflation were the only objective, the gold standard did not deliver that.

Between 1873 and 1896, for example, the general price level fell by 53% in the US and by 45% in the United Kingdom, owing to a dearth of new gold discoveries, which ended only with the 1896 Klondike gold rush.

Moreover, economies do better when central banks, in addition to seeking price stability, pursue financial stability and act to stabilize income and employment. The Fed’s monetary stimulus in 2008-12, when unemployment reached 9%, was thus the right policy. Conversely, tightening was appropriate in 2016-18, when US unemployment fell below 4%.

Had the Fed instead followed the gold market, it would have tightened monetary policy in 2010, prolonging the period of high unemployment, and loosened policy in 2018. Stimulus was again the right decision when the coronavirus recession hit – but true believers in gold would take the recent record price as a sign that the Fed should tighten policy aggressively.

Then there is Shelton’s ideological inconsistency. As soon as the prospect of attaining high office arose, she contradicted her long-standing philosophy in order to say what Trump wanted to hear – namely, that the Fed should loosen monetary policy even faster.

Were Shelton to join the Fed board, neither the price of gold nor what is good for the economy would likely determine her vote. Should Democratic presidential nominee Joe Biden win in November, she would almost certainly reconnect with gold and rediscover the urgent need to tighten policy – even if the economy is still very weak.

But if Trump is re-elected, she will probably vote to double down on the current monetary stimulus, even if inflation revives.

We have become accustomed to toadyism and cronyism under Trump, from the Justice Department to the US Postal Service. Until now, the Fed has been blessedly free of these scourges – but perhaps not for much longer.


Jeffrey Frankel, Professor of Capital Formation and Growth at Harvard University, previously served as a member of President Bill Clinton’s Council of Economic Advisers. He is a research associate at the US National Bureau of Economic Research.